The recent European debt crisis has sparked a heated debate on the merits of fiscal austerity. Since the main objective of the proposed fiscal tightenings is to reduce sovereign default risk, the solution to this debate depends on the costs of a sovereign debt restructuring. One important cost...

We study a model in which households are subject to uninsurable idiosyncratic employment shocks, firms set prices subject to nominal rigidities, and the labor market is characterized by matching frictions and by downward in flexible wages. We introduce heterogeneity in search efficiency that...